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FORM 10 - Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the nine months ended September 30, 2002
Commission file number 0-11716
COMMUNITY BANK SYSTEM, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 16-1213679
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5790 Widewaters Parkway, DeWitt, New York 13214
(Address of principal executive offices) (Zip Code)
315/445-2282
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
Common Stock, No par value - 12,966,591 shares
outstanding as of November 8, 2002
INDEX
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Consolidated Statements of Condition --
September 30, 2002, December 31, 2001 and September 30, 2001
Consolidated Statements of Income --
Three and nine months ended September 30, 2002 and 2001
Consolidated Statement of Shareholders' Equity --
Nine months ended September 30, 2002
Consolidated Statements of Comprehensive Income --
Nine months ended September 30, 2002 and 2001
Consolidated Statements of Cash Flows --
Nine months ended September 30, 2002, and 2001
Notes to Consolidated Financial Statements -
September 30, 2002
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Item 3. Quantitative and Qualitative Disclosure about Market Risk
Part II. Other Information
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Securities Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
2
CONSOLIDATED STATEMENTS OF CONDITION (Unaudited)
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
(In Thousands, Except Share Data)
September 30, December 31, September 30,
2002 2001 2001
- -----------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $ 103,178 $ 106,554 $ 85,579
Federal funds sold 0 0 0
- -----------------------------------------------------------------------------------------------------
Total cash and cash equivalents 103,178 106,554 85,579
Investment securities 1,356,863 1,148,182 1,050,856
Loans 1,779,440 1,732,870 1,564,806
Allowance for loan losses 24,080 23,901 21,083
- -----------------------------------------------------------------------------------------------------
Net loans 1,755,360 1,708,969 1,543,723
Premises and equipment, net 56,907 53,266 44,170
Accrued interest receivable 23,149 22,562 21,723
Core deposit intangibles, net 32,081 36,722 9,039
Goodwill, net 103,628 19,814 21,285
Other intangibles, net (see Note A) 85,806 36,672
- -----------------------------------------------------------------------------------------------------
Intangible assets, net 135,709 142,342 66,996
Other assets 37,426 28,958 31,303
- -----------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 3,468,592 $ 3,210,833 $ 2,844,350
=====================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits
Noninterest bearing $ 450,131 $ 447,544 $ 350,622
Interest bearing 2,101,604 2,098,426 1,737,484
- -----------------------------------------------------------------------------------------------------
Total deposits 2,551,735 2,545,970 2,088,106
Federal funds purchased 11,500 14,200 41,100
Borrowings 439,100 263,100 338,100
Company obligated mandatorily redeemable preferred
securities of subsidiaries, Community Capital/Statutory
Trust I-III, holding solely junior subordinated
debentures of the Company 77,361 77,819 77,805
Accrued interest and other liabilities 64,735 41,764 48,553
- -----------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 3,144,431 2,942,853 2,593,664
- -----------------------------------------------------------------------------------------------------
Shareholders' equity:
Common stock no par $1.00 stated value
20,000,000 shares authorized; 12,962,549, 12,902,812
and 11,579,312 shares outstanding, respectively 12,963 12,903 11,579
Surplus 78,987 77,710 46,710
Undivided profits 188,604 170,472 169,127
Accumulated other comprehensive income 43,728 7,281 23,633
Shares issued under employee stock plan - unearned (121) (386) (363)
- -----------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 324,161 267,980 250,686
- -----------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 3,468,592 $ 3,210,833 $ 2,844,350
=====================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
3
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
(In Thousands, Except Per-Share Data)
Three Months Ended Nine Months Ended
September 30, September 30,
- -------------------------------------------------------------------------------------------------------
2002 2001 2002(1) 2001
- -------------------------------------------------------------------------------------------------------
Interest income:
Interest and fees on loans $ 32,816 $32,635 $ 97,952 $ 99,408
Interest and dividends on investments:
Taxable 14,169 13,057 43,172 41,412
Nontaxable 4,530 2,726 12,389 7,302
Interest on federal funds and deposits with other banks 1 173 4 561
- -------------------------------------------------------------------------------------------------------
Total interest income 51,516 48,591 153,517 148,683
- -------------------------------------------------------------------------------------------------------
Interest expense:
Interest on deposits 13,099 17,689 42,110 56,606
Interest on federal funds purchased 156 84 392 733
Interest on short-term borrowings 674 752 1,289 5,425
Interest on madatorily redeemable preferred
securities of subsidiaries 1,439 1,452 4,336 2,918
Interest on long-term borrowings 3,751 4,805 11,387 12,973
- -------------------------------------------------------------------------------------------------------
Total interest expense 19,119 24,782 59,514 78,655
- -------------------------------------------------------------------------------------------------------
Net interest income 32,397 23,809 94,003 70,028
Less: provision for loan losses 2,278 1,579 7,180 4,320
- -------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 30,119 22,230 86,823 65,708
- -------------------------------------------------------------------------------------------------------
Other income:
Fiduciary and investment services 707 801 2,484 2,327
Service charges on deposit accounts 3,343 2,530 9,384 7,271
Commissions on investment products 1,336 1,498 5,249 4,668
Other service charges, commissions and fees 2,490 2,050 6,065 5,217
Other operating income (4) 102 (8) 104
Investment security gain, net 216 2,688 1,359 2,559
- -------------------------------------------------------------------------------------------------------
Total other income 8,088 9,669 24,533 22,146
- -------------------------------------------------------------------------------------------------------
Other expenses:
Salaries and employee benefits 12,020 9,879 36,411 30,321
Occupancy expense, net 1,781 1,464 6,179 4,554
Equipment and furniture expense 1,714 1,518 5,569 4,416
Amortization of intangible assets 1,597 1,541 4,641 4,542
Legal and professional fees 845 745 2,380 2,063
Data processing expenses 1,813 1,340 5,234 3,815
Acquisition and unusual expenses 0 631 700 6,117
Other 3,299 3,263 10,683 9,223
- -------------------------------------------------------------------------------------------------------
Total other expenses 23,069 20,381 71,797 65,051
- -------------------------------------------------------------------------------------------------------
Income before income taxes and extraordinary item 15,138 11,518 39,559 22,803
Income taxes 4,087 2,416 10,681 5,842
Income before extraordinary item 11,051 9,102 28,878 16,961
Extraordinary loss on early retirement of long
term borrowings, net of tax benefit of $1,077 0 2,659 0 2,659
- -------------------------------------------------------------------------------------------------------
NET INCOME $ 11,051 $ 6,443 $ 28,878 $ 14,302
=======================================================================================================
Earnings per share - Basic $ 0.85 $ 0.56 $ 2.23 $ 1.25
=======================================================================================================
Earnings per share - Diluted $ 0.84 $ 0.55 $ 2.19 $ 1.23
=======================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements. (1) The consolidated statements of income for the three months ended
March 31 and June 30, 2002 and the six months ended June 30, 2002 were restated
for the adoption of SFAS 147.
4
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited)
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
Nine Months Ended September 30, 2002
(In Thousands, Except Share Data)
Accumulated Shares Issued
Common Stock Other Under Employee
Shares Undivided Comprehensive Stock Plan
Outstanding Amount Surplus Profits Income -Unearned Total
- --------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 12,902,812 $12,903 $77,710 $ 170,472 $ 7,281 ($386) $ 267,980
Net income 28,878 28,878
Other comprehensive income, net of tax 36,447 36,447
Dividends declared:
Common, $.83 per share (10,746) (10,746)
Common stock issued under employee stock plan 59,737 60 1,277 265 1,602
- --------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2002 12,962,549 $12,963 $78,987 $ 188,604 $43,728 ($121) $ 324,161
================================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
5
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
(In Thousands)
Nine Months Ended
September 30,
2002 2001
- -----------------------------------------------------------------------------------
Other comprehensive income, before tax:
Change in minimum pension liability adjustment $ 4,919 $ 0
Unrealized gain on securities:
Unrealized holding gains arising during period 57,212 32,018
Reclassification adjustment for (gains) losses included
in net income (1,359) (2,559)
- -----------------------------------------------------------------------------------
Other comprehensive income, before tax 60,772 29,459
Income tax expense related to other comprehensive income (24,325) (11,791)
- -----------------------------------------------------------------------------------
Other comprehensive income, net of tax 36,447 17,668
Net income 28,878 14,302
- -----------------------------------------------------------------------------------
Comprehensive income $ 65,325 $ 31,970
===================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
6
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
(In Thousands)
Nine Months Ended
September 30,
- ------------------------------------------------------------------------------------
2002 2001
- ------------------------------------------------------------------------------------
Operating Activities:
Net income $ 28,878 $ 14,302
Adjustments to reconcile net income to net cash provided
by operating activities
Depreciation 4,868 3,661
Amortization of intangible assets 4,641 4,542
Net amortization of security premiums and discounts 3,081 1,528
Amortization of discount of loans (81) (160)
Amortization of unearned compensation and discount on
junior subordinated debentures 340 95
Provision for loan losses 7,180 4,320
Provision for deferred taxes 4,594 589
Gain on sale of investment securities (1,359) (2,559)
Loss (gain) on sale of loans and other assets 7 (97)
Change in interest receivable (587) 1,160
Change in other assets and other liabilities (9,416) 3,127
- ------------------------------------------------------------------------------------
Net cash provided by operating activities 42,146 30,508
- ------------------------------------------------------------------------------------
Investing Activities:
Proceeds from sales of investment securities 75,782 139,414
Proceeds from maturities of held-to-maturity
investment securities 3,862 4,978
Proceeds from maturities of available-for-sale
investment securities 129,790 169,072
Purchases of held-to-maturity investment securities (3,498) (3,480)
Purchases of available-for-sale investment securities (360,491) (354,823)
Net change in loans outstanding (53,483) 6,040
Premium paid on acquisition of business 0 (2,993)
Cash received in acquisition 0 3,777
Capital expenditures (6,560) (5,398)
- ------------------------------------------------------------------------------------
Net cash used by investing activities (214,598) (43,413)
- ------------------------------------------------------------------------------------
Financing Activities:
Net change in demand deposits, NOW accounts, and
savings accounts 49,952 46,456
Net change in certificates of deposit (44,187) 5,422
Net change in federal funds purchased (2,700) (7,630)
Net change in borrowings 175,500 (62,950)
Proceeds from issuance of redeemable preferred securities 0 47,967
Issuance of common stock 1,064 703
Cash dividends paid (10,469) (7,856)
Other financing activities (84) (84)
- ------------------------------------------------------------------------------------
Net cash provided by financing activities 169,076 22,027
- ------------------------------------------------------------------------------------
Change in cash and cash equivalents (3,376) 9,122
Cash and cash equivalents at beginning of year 106,554 76,456
- ------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 103,178 $ 85,579
====================================================================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest $ 60,163 $ 77,345
Cash paid for income taxes $ 4,927 $ 6,142
====================================================================================
SUPPLEMENTAL DISCLOSURES OF NONCASH FINANCING AND
INVESTING ACTIVITIES:
Dividends declared and unpaid $ 3,759 $ 3,124
Gross change in unrealized gains and (losses) on
available-for-sale securities $ 55,853 ($ 29,459)
Change in minimum pension liability adjustment ($ 4,919) $ 0
Bank acquisition:
Fair value of assets acquired $ 0 $ 123,948
Liabilities assumed $ 0 $ 98,720
Common stock issued, including treasury stock
of $0 and $17,006 $ 0 $ 25,228
====================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
7
Community Bank System, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
September 30, 2002
Note A -- Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments considered
necessary for fair presentation have been included. Operating results for the
three and nine month periods ended September 30, 2002 are not necessarily
indicative of the results that may be expected for the year ended December 31,
2002.
On November 16, 2001, the Company acquired 36 branches from FleetBoston
Financial Corporation with $470 million in deposits and $177 million in loans.
The branches are located in Southwestern and Finger Lakes Regions of New York.
The results of the 36 branch operations have been included in the consolidated
financial statements since that date.
On May 11, 2001, the Company completed its acquisition of the $648-million-asset
First Liberty Bank Corp. ("First Liberty"). Pursuant to the terms of the merger,
each share of First Liberty stock was exchanged for .56 shares of the Company's
common stock, which amounted to approximately 3.6 million shares. The merger
constituted a tax-free reorganization and has been accounted for as a pooling of
interests under Accounting Principles Board Opinion No. 16. Accordingly, the
consolidated financial statements for the periods presented have been restated
to include the combined results of operations, financial position and cash flows
of the Company and First Liberty.
On January 26, 2001, the Company acquired the $111-million-asset Citizens
National Bank of Malone, an eighty-year old commercial bank with five branches
throughout Franklin and St. Lawrence counties in New York State. The Company
issued 952,000 shares of its common stock to the former shareholders at a cost
of $26.50 per share. All of the 648,100 shares held in the Company's treasury
were issued in this transaction. The results of operations from this transaction
have been included in the Company's consolidated financial statements since the
acquisition date.
During the first quarter of 2002, the Company made a contribution of $5.0
million to its defined benefit pension plan. At March 31, 2002, an updated
actuarial valuation was performed which showed that plan assets exceeded the
accumulated benefit obligation. As a result, the additional minimum pension
liability of $4.919 million, which was recorded at December 31, 2001 as a charge
to shareholders' equity, net of tax, was reversed.
On October 1, 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 147 (SFAS 147), "Accounting for
Certain Acquisitions of Banking or Thrift Institutions." Under previous SFAS,
goodwill arising from branch acquisitions was classified as an "unidentifiable
intangible asset" and subject to regular amortization. SFAS 147 changes the
accounting for goodwill arising from branch acquisitions and allows the Company
to cease amortization on this goodwill and subject it to an annual impairment
test. In accordance with the provisions of SFAS 147, the Company has adopted
this Statement retroactive to January 1, 2002, with the impact of restatement on
previously issued Form 10Q's as of March 31, 2002 and June 30, 2002 contained
below.
8
Three Months Three Months Six Months
Ended March Ended June Ended June
($000s except for earnings-per-share amounts) 31, 2002 30, 2002 30, 2002
----------------------------------------
Net income as previously reported $ 7,438 $ 8,179 $ 15,617
Plus: branch goodwill amortization, net of tax 1,122 1,090 2,211
----------------------------------------
Net income as restated $ 8,560 $ 9,269 $ 17,828
Basic EPS as previously reported $ 0.57 $ 0.63 $ 1.21
Diluted EPS as previously reported $ 0.57 $ 0.62 $ 1.19
Basic EPS as restated $ 0.66 $ 0.71 $ 1.38
Diluted EPS as restated $ 0.65 $ 0.70 $ 1.36
Note B -- Critical Accounting Policies
Allowance for Loan Losses
The allowance for loan losses reflects management's best estimate of probable
loan losses in the Company's loan portfolio, considering evaluations of
individual credits and concentrations of credit risk, changes in the quality of
the credit portfolio, levels of nonaccrual loans, current economic conditions,
changes in the size and character of the credit risks and other pertinent
factors. The allowance is increased by provisions charged to expense and reduced
by net charge-offs. A loan is considered impaired, based on current information
and events, if it is probable that the Bank will not be able to collect the
scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. The measurement of impaired loans is
generally based on the present value of expected future cash flows discounted at
the historical effective interest rate, except that all collateral-dependent
loans are measured for impairment based on the fair value of the collateral.
New Accounting Pronouncements
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which addresses financial accounting and
reporting for the impairment of long-lived assets and for long-lived assets to
be disposed of, including long-term customer relationships of a financial
institution, such as core deposit intangibles. This Statement supersedes SFAS
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of;" however, this Statement retains the fundamental
provisions of Statement 121 for (a) recognition and measurement of the
impairment of long-lived assets to be held and used, and (b) measurement of
long-lived assets to be disposed of by sale. Effective January 1, 2002, the
Company adopted this pronouncement, which had no impact on the financial
condition or results of operations for the quarter and nine months ended
September 30, 2002.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which addresses financial accounting and
reporting for costs associated with exit or disposal activities. This Statement
supersedes Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit and Activity
(including Certain Costs Incurred in a Restructuring)." The provisions of this
Statement are effective for exit or disposal activities that are initiated after
December 31, 2002, with early application encouraged. The Company is not
anticipating that this pronouncement will have a significant impact on the
financial condition or results of its operations.
See Notes A and D for discussion of recent accounting pronouncements regarding
goodwill and intangible assets.
9
Note C -- Earnings Per Share
Basic earnings per share are computed based on the weighted average shares
outstanding. Diluted earnings per share is computed based on the weighted
average shares outstanding adjusted for the dilutive effect of the assumed
exercise of stock options during the year. The dilutive effect of options is
calculated using the treasury stock method of accounting sanctioned by the FASB.
This calculation determines approximately how many more common shares would be
outstanding if all in-the-money (average market price is greater than the
exercise price) vested and unvested options outstanding were exercised and the
proceeds were used to repurchase common shares in the open market at the average
price for the applicable time period. The following is a reconciliation of basic
to diluted earnings per share for the three and nine months ended September 30,
2002 and 2001.
Per Share
(In thousands except per share data) Income Shares Amount
- ----------------------------------------------------------------------------------------------------
Quarter ended September 30, 2002 Net income $11,051
Basic EPS 11,051 12,985 $0.85
Effect of dilutive
securities:
Stock options 187
--------------------
Diluted EPS $11,051 13,172 $0.84
====================================================================================================
Quarter ended September 30, 2001 Net income $6,443
Basic EPS 6,443 11,591 $0.56
Effect of dilutive
securities:
Stock options 145
--------------------
Diluted EPS $6,443 11,736 $0.55
====================================================================================================
Nine months ended September 30, 2002 Net income $28,878
Basic EPS 28,878 12,966 $2.23
Effect of dilutive
securities:
Stock options 191
--------------------
Diluted EPS $28,878 13,157 $2.19
====================================================================================================
Nine months ended September 30, 2001 Net income $14,302
Basic EPS 14,302 11,483 $1.25
Effect of dilutive
securities:
Stock options 154
--------------------
Diluted EPS $14,302 11,637 $1.23
====================================================================================================
10
Note D -- Intangible Assets
Effective January 1, 2002, the Company adopted Financial Accounting Standards
Board (FASB) SFAS No. 142, "Goodwill and Other Intangible Assets", which
addresses financial accounting and reporting for acquired goodwill and other
intangible assets and supercedes APB Opinion No. 17, "Intangible Assets". The
statement requires that the Company subject goodwill and other intangible assets
to an annual impairment analysis to assess the need to write down the balances
and recognize an impairment loss. In addition, amortization of goodwill is no
longer being recorded in accordance with this statement. Core deposit
intangibles, net and other intangibles, net (primarily branch goodwill related
to branch acquisitions) will continue to be amortized. The adoption of this
pronouncement resulted in a reduction in amortization expense of $325,000 and
$975,000 for the quarter and nine months ended September 30, 2002, respectively.
In October 2002, the FASB issued SFAS No. 147, "Accounting for Certain
Acquisitions of Banking and Thrift Institutions", which addresses financial
accounting and reporting for certain intangibles associated with branch
acquisitions. This statement removes acquisitions of financial institutions from
the scope of SFAS No. 72 and FASB Interpretation No. 9. It reclassifies as
goodwill certain "unidentified intangible assets" associated with the Company's
branch acquisitions dating as far back as 1994. Financial statements are
retroactively restated to January 1, 2002 to remove amortization recorded on
Other Intangible Assets. Previously, these intangible assets were subject to
being regularly amortized. As discussed above, under FASB 142, goodwill is not
required to be amortized, but as an asset, is periodically reviewed for
impairment. The adoption of this pronouncement resulted in a reduction in
amortization expense of approximately $1.5 million and $4.5 million for the
quarter and nine months ended September 30, 2002, respectively.
The proforma disclosures on net income and earnings per share of SFAS No. 142
and SFAS No. 147 for the quarter and nine months ended September 30, 2002 and
2001 are as follows:
($000s except for
earnings-per-share amounts) Quarter Ended Nine Months Ended
September 30, September 30,
------------------------------------------------
2002 2001 2002 2001
------------------------------------------------
Reported net income $ 11,051 $ 6,443 $ 28,878 $ 14,302
Add back: Goodwill amortization 660 1,931
------------------------------------------------
Adjusted net income $ 11,051 $ 7,103 $ 28,878 $ 16,233
================================================
Basic earnings per share:
Reported net income $ 0.85 $ 0.56 $ 2.23 $ 1.25
Add back: Goodwill amortization 0.05 0.16
------------------------------------------------
Adjusted net income $ 0.85 $ 0.61 $ 2.23 $ 1.41
================================================
Diluted earnings per share:
Reported net income $ 0.84 $ 0.55 $ 2.19 $ 1.23
Add back: Goodwill amortization 0.06 0.16
------------------------------------------------
Adjusted net income $ 0.84 $ 0.61 $ 2.19 $ 1.39
================================================
11
The gross carrying amount and accumulated amortization for each type of
intangible asset are as follows:
As of September 30, 2002 As of December 31, 2001
--------------------------------------------------------------------------------
Gross Net Gross Net
($000s) Carrying Accumulated Carrying Carrying Accumulated Carrying
Amount Amortization Amount Amount Amortization Amount
--------------------------------------------------------------------------------
Amortized intangible assets:
Core deposit intangibles $47,218 ($15,137) $32,081 $47,218 ($10,496) $36,722
--------------------------------------------------------------------------------
Total amortized intangible assets 47,218 (15,137) 32,081 47,218 (10,496) 36,722
Unamortized intangible assets:
Goodwill 122,001 (18,373) 103,628 123,993 (18,373) 105,620
--------------------------------------------------------------------------------
Total intangible assets, net $169,219 ($33,510) $135,709 $171,211 ($28,869) $142,342
================================================================================
The decrease of $1,992 in the gross carrying value of goodwill pertains to the
FleetBoston acquisition, specifically an adjustment to fair value of the Bank
premises and equipment and reflecting deferred taxes on the allowance for loan
losses and conversion costs. The Company completed its goodwill impairment
analysis during 2002, and no adjustment was necessary.
The estimated aggregate amortization expense for each of the five succeeding
fiscal years ended December 31, is as follows:
2003 $4,970
2004 4,753
2005 4,079
2006 3,406
2007 3,406
12
Part 1. Financial Information
Item 1. Financial Statements
The information required by rule 10.01 of Regulation S-X is presented on the
previous pages.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The purpose of the discussion is to present material changes in Community Bank
System, Inc.'s financial condition and results of operations during the three
and nine months ended September 30, 2002 which are not otherwise apparent from
the consolidated financial statements included in these reports. When used in
this report, the term "CBSI" or "CBU" means Community Bank System, Inc. and its
subsidiaries on a consolidated basis, unless indicated otherwise. Financial
performance comparisons to peer bank holding companies are based on data through
June 30, 2002 as provided by the Federal Reserve System; the peer group is
comprised of 73 bank holding companies having $3 to $10 billion in assets.
13
COMMUNITY BANK SYSTEM, INC.
SUMMARY OF OPERATIONS
EARNINGS AND BALANCE SHEET RECAP
3RD QUARTER 2002 AND FULL YEAR COMPARISONS
----------------------------------------------------------------
000's Omitted Three Months Ended
----------------------------------------------------------------------------------------------------------------------
Line Sep 30, Sep 30, Change Change
No. 2002 2001 Amount Percent
----------------------------------------------------------------------------------------------------------------------
Earnings
------------------------------------------------------
1 Net interest income $32,397 $23,809 $8,588 36.1%
2 Loan loss provision 2,278 1,579 699 44.3%
3 Net interest income after provision for loan losses 30,119 22,230 7,889 35.5%
4a Financial services other income 3,689 3,688 1 0.0%
4b Banking services other income 4,183 3,293 890 27.0%
4c Investment security gain (loss) & debt extinguishment 216 29 187 644.8%
4d Total other income 8,088 7,010 1,078 15.4%
5a Financial services other expenses 2,500 2,560 (60) -2.3%
5b Banking services other expenses 18,972 15,649 3,323 21.2%
5c Intangible amortization 1,597 1,541 56 3.6%
5d Acquisition and unusual expense 0 631 (631) 0.0%
5e Total other expenses 23,069 20,381 2,688 13.2%
6 Income before taxes 15,138 8,859 6,279 70.9%
7 Income tax 4,087 2,416 1,671 69.2%
8a Net income $11,051 $6,443 $4,608 71.5%
8b Net income - Operating $11,051 $6,801 $4,250 62.5%
8c Net income - Cash $12,021 $7,451 $4,570 61.3%
8d Net income - Cash Operating $12,021 $7,809 $4,212 53.9%
9a Basic earnings per share $0.85 $0.56 $0.29 51.8%
9b Diluted earnings per share $0.84 $0.55 $0.29 52.7%
9c Diluted earnings per share-Operating $0.84 $0.58 $0.26 44.8%
9d Diluted earnings per share-Cash $0.91 $0.63 $0.28 44.4%
9e Diluted earnings per share-Cash Operating $0.91 $0.67 $0.24 35.8%
------------------------------------------------------================================================================
Balances At Period End
------------------------------------------------------
10 Loans $1,779,440 $1,564,806 $214,634 13.7%
11 Investments & other interest bearing accounts 1,284,695 1,011,354 273,341 27.0%
(excluding market value adjustment)
12 Earning assets 3,064,135 2,576,160 487,975 18.9%
13 Loan loss reserve 24,080 21,083 2,997 14.2%
14a Core deposit intangibles,net 32,081 9,039 23,042 254.9%
14b Goodwill & other intangibles, net 103,628 57,957 45,671 78.8%
14c Total intangible assets, net 135,709 66,996 68,713 102.6%
15 Total assets 3,468,592 2,844,350 624,242 21.9%
16 Deposits 2,551,735 2,088,106 463,629 22.2%
17a FHLB borrowings 450,600 379,200 71,400 18.8%
17b Trust preferred borrowings 77,361 77,805 (444) -0.6%
17c Total borrowings 527,961 457,005 70,956 15.5%
18 Total shareholders' equity 324,161 250,686 73,475 29.3%
19 Assets under management $1,267,289 $1,237,554 $29.735 2.4%
================================================================
14
----------------------------------------------------------------
000's Omitted Nine Months Ended
----------------------------------------------------------------------------------------------------------------------
Line Six Months Ended June 30, 2002 Restated for SFAS 147 Sep 30, Sep 30, Change Change
No. 2002 2001 Amount Percent
----------------------------------------------------------------------------------------------------------------------
Earnings
------------------------------------------------------
1 Net interest income $94,003 $70,028 $23,975 34.2%
2 Loan loss provision 7,180 4,320 2,860 66.2%
3 Net interest income after provision for loan losses 86,823 65,708 21,115 32.1%
4a Financial services other income 10,881 9,672 1,209 12.5%
4b Banking services other income 12,293 9,915 2,378 24.0%
4c Investment security gain (loss) & debt extinguishment 1,359 (100) 1,459 -1459.0%
4d Total other income 24,533 19,487 5,046 25.9%
5a Financial services other expenses 7,870 7,492 378 5.0%
5b Banking services other expenses 58,586 46,900 11,686 24.9%
5c Intangible amortization 4,641 4,542 99 2.2%
5d Acquisition and unusual expense 700 6,117 (5,417) -88.6%
5e Total other expenses 71,797 65,051 6,746 10.4%
6 Income before taxes 39,559 20,144 19,415 96.4%
7 Income tax 10,681 5,842 4,839 82.8%
8a Net income $28,878 $14,302 $14,576 101.9%
8b Net income - Operating $29,303 $18,000 $11,303 62.8%
8c Net income - Cash $31,697 $17,247 $14,450 83.8%
8d Net income - Cash Operating $32,122 $20,945 $11,177 53.4%
9a Basic earnings per share $2.23 $1.25 $0.98 78.4%
9b Diluted earnings per share $2.19 $1.23 $0.96 78.0%
9c Diluted earnings per share-Operating $2.23 $1.55 $0.68 43.9%
9d Diluted earnings per share-Cash $2.41 $1.48 $0.93 62.8%
9e Diluted earnings per share-Cash Operating $2.44 $1.80 $0.64 35.6%
------------------------------------------------------================================================================
Balances At Period End
------------------------------------------------------
10 Loans $1,779,440 $1,564,806 $214,634 13.7%
11 Investments & other interest bearing accounts 1,284,695 1,011,354 273,341 27.0%
(excluding market value adjustment)
12 Earning assets 3,064,135 2,576,160 487,975 18.9%
13 Loan loss reserve 24,080 21,083 2,997 14.2%
14a Core deposit intangibles,net 32,081 9,039 23,042 254.9%
14b Goodwill & other intangibles, net 103,628 57,957 45,671 78.8%
14c Total intangible assets, net 135,709 66,996 68,713 102.6%
15 Total assets 3,468,592 2,844,350 624,242 21.9%
16 Deposits 2,551,735 2,088,106 463,629 22.2%
17a FHLB borrowings 450,600 379,200 71,400 18.8%
17b Trust preferred borrowings 77,361 77,805 (444) -0.6%
17c Total borrowings 527,961 457,005 70,956 15.5%
18 Total shareholders' equity 324,161 250,686 73,475 29.3%
19 Assets under management $1,267,289 $1,237,554 $29.735 2.4%
================================================================
15
----------------------------------------------------------------
000's Omitted Three Months Ended
----------------------------------------------------------------------------------------------------------------------
Line Three Months Ended June 30, 2002 Restated for SFAS 147 Sep 30, Jun 30, Change Change
No. ------------------------------------------------------ 2002 2002 Amount Percent
- --------------------------------------------------------------------------------------------------------------------------------
Earnings
------------------------------------------------------
1 Net interest income $32,397 $31,438 $959 3.1%
2 Loan loss provision 2,278 3,385 (1,107) -32.7%
3 Net interest income after provision for loan losses 30,119 28,053 2,066 7.4%
4a Financial services other income 3,689 3,550 139 3.9%
4b Banking services other income 4,183 4,017 166 4.1%
4c Investment security gain (loss) & debt extinguishment 216 1,144 (928) -81.1%
4d Total other income 8,088 8,711 (623) -7.2%
5a Financial services other expenses 2,500 2,645 (145) -5.5%
5b Banking services other expenses 18,972 19,822 (850) -4.3%
5c Intangible amortization 1,597 1,504 93 6.2%
5d Acquisition and unusual expense 0 108 (108) 0.0%
5e Total other expenses 23,069 24,079 (1,010) -4.2%
6 Income before taxes 15,138 12,685 2,453 19.3%
7 Income tax 4,087 3,416 671 19.6%
8a Net income $11,051 $9,269 $1,782 19.2%
8b Net income - Operating $11,051 $9,335 $1,716 18.4%
8c Net income - Cash $12,021 $10,182 $1,839 18.1%
8d Net income - Cash Operating $12,021 $10,248 $1,773 17.3%
9a Basic earnings per share $0.85 $0.71 $0.14 19.7%
9b Diluted earnings per share $0.84 $0.70 $0.14 20.0%
9c Diluted earnings per share-Operating $0.84 $0.71 $0.13 18.3%
9d Diluted earnings per share-Cash $0.91 $0.77 $0.14 18.2%
9e Diluted earnings per share-Cash Operating $0.91 $0.78 $0.13 16.7%
------------------------------------------------------================================================================
Balances At Period End
------------------------------------------------------
10 Loans $1,779,440 $1,751,184 $28,256 1.6%
11 Investments & other interest bearing accounts 1,284,695 1,281,724 2,971 0.2%
(excluding market value adjustment)
12 Earning assets 3,064,135 3,032,908 31,227 1.0%
13 Loan loss reserve 24,080 23,883 197 0.8%
14a Core deposit intangibles,net 32,081 33,678 (1,597) -4.7%
14b Goodwill & other intangibles, net 103,628 102,602 1,026 1.0%
14c Total intangible assets, net 135,709 136,280 (571) -0.4%
15 Total assets 3,468,592 3,408,893 59,699 1.8%
16 Deposits 2,551,735 2,513,261 38,474 1.5%
17a FHLB borrowings 450,600 472,200 (21,600) -4.6%
17b Trust preferred borrowings 77,361 77,347 14 0.0%
17c Total borrowings 527,961 549,547 (21,586) -3.9%
18 Total shareholders' equity 324,161 298,529 25,632 8.6%
19 Assets under management $1,267,289 $1,370,346 ($103,057) -7.5%
================================================================
16
----------------------------------------------------------------
000's Omitted Three Months Ended
----------------------------------------------------------------------------------------------------------------------
Line Sep 30, Sep 30, Change Change
No. 2002 2001 Amount Percent
----------------------------------------------------------------------------------------------------------------------
Profitability
------------------------------------------------------
20 Return on assets 1.28% 0.90% 0.38 %pts.
21a Return on equity 14.56% 10.73% 3.83 %pts.
21b Return on equity - operating 14.56% 11.33% 3.23 %pts.
22 Tangible return on assets 1.39% 1.04% 0.35 %pts.
23a Tangible return on equity 15.84% 12.41% 3.43 %pts.
23b Tangible return on equity - operating 15.84% 13.01% 2.83 %pts.
24 Net interest margin (FTE) 4.61% 3.94% 0.67 %pts.
25 Non interest income/operating income (FTE) 18.2% 21.3% (3.1) %pts.
(excluding net security gains & branch disposition)
26 Efficiency ratio 49.7% 55.6% (5.9) %pts.
(excluding acquisition & unusual expenses
& intangible amortization)
------------------------------------------------------================================================================
Capital
------------------------------------------------------
27 Tier I leverage ratio 6.87% 8.72% (1.85) %pts.
28 Tangible equity / assets 5.65% 6.61% (0.96) %pts.
29 Accumulated other comprehensive income $43,728 $23,633 $20,095 85.0%
30 Diluted weighted average common shares outstanding 13,172 11,736 1,436 12.2%
31 Period end common shares outstanding 12,963 11,579 1,384 12.0%
32 Cash dividends declared per common share $0.29 $0.27 $0.02 7.4%
33 Common stock price $29.63 $27.50 $2.13 7.7%
34 Total return - last 12 months 11.8% 10.3% 1.5 %pts.
35 Book value $25.01 $21.65 $3.36 15.5%
36 Tangible book value $14.54 $15.86 ($1.32) -8.3%
------------------------------------------------------================================================================
Asset Quality Ratios
------------------------------------------------------
37 Loan loss reserve / 1.35% 1.35% 0.00 %pts.
loans outstanding
38 Nonperforming loans / 0.69% 0.54% 0.15 %pts.
loans outstanding
39 Loan loss reserve / 197% 247% (50) %pts.
nonperforming loans
40 Net charge-offs / 0.47% 0.34% 0.13 %pts.
average loans
41 Loan loss provision / 110% 116% (6) %pts.
net charge-offs
42 Nonperforming assets / 0.75% 0.67% 0.08 %pts.
loans outstanding + OREO
================================================================
17
----------------------------------------------------------------
000's Omitted Nine Months Ended
----------------------------------------------------------------------------------------------------------------------
Line Six Months Ended June 30, 2002 Restated for SFAS 147 Sep 30, Sep 30, Change Change
No. 2002 2001 Amount Percent
----------------------------------------------------------------------------------------------------------------------
Profitability
------------------------------------------------------
20 Return on assets 1.15% 0.67% 0.48 %pts.
21a Return on equity 13.50% 8.30% 5.20 %pts.
21b Return on equity - operating 13.70% 10.44% 3.26 %pts.
22 Tangible return on assets 1.26% 0.81% 0.45 %pts.
23a Tangible return on equity 14.82% 10.01% 4.81 %pts.
23b Tangible return on equity - operating 15.01% 12.15% 2.86 %pts.
24 Net interest margin (FTE) 4.56% 3.88% 0.68 %pts.
25 Non interest income/operating income (FTE) 18.1% 20.6% (2.5) %pts.
(excluding net security gains & branch disposition)
26 Efficiency ratio 52.9% 57.3% (4.4) %pts.
(excluding acquisition & unusual expenses
& intangible amortization)
------------------------------------------------------================================================================
Capital
------------------------------------------------------
27 Tier I leverage ratio 6.87% 8.72% (1.85) %pts.
28 Tangible equity / assets 5.65% 6.61% (0.96) %pts.
29 Accumulated other comprehensive income $43,728 $23,633 $20,095 85.0%
30 Diluted weighted average common shares outstanding 13,157 11,637 1,520 13.1%
31 Period end common shares outstanding 12,963 11,579 1,384 12.0%
32 Cash dividends declared per common share $0.83 $0.81 $0.02 2.5%
33 Common stock price $29.63 $27.50 $2.13 7.7%
34 Total return - last 12 months 11.8% 10.3% 1.5 %pts.
35 Book value $25.01 $21.65 $3.36 15.5%
36 Tangible book value $14.54 $15.86 ($1.32) -8.3%
------------------------------------------------------================================================================
Asset Quality Ratios
------------------------------------------------------
37 Loan loss reserve / 1.35% 1.35% 0.00 %pts.
loans outstanding
38 Nonperforming loans / 0.69% 0.54% 0.15 %pts.
loans outstanding
39 Loan loss reserve / 197% 247% (50) %pts.
nonperforming loans
40 Net charge-offs / 0.54% 0.35% 0.19 %pts.
average loans
41 Loan loss provision / 103% 106% (3) %pts.
net charge-offs
42 Nonperforming assets / 0.75% 0.67% 0.08 %pts.
loans outstanding + OREO
================================================================
18
----------------------------------------------------------------
000's Omitted Three Months Ended
----------------------------------------------------------------------------------------------------------------------
Line Three Months Ended June 30, 2002 Restated for SFAS 147 Sep 30, Jun 30, Change Change
No. 2002 2002 Amount Percent
----------------------------------------------------------------------------------------------------------------------
Profitability
------------------------------------------------------
20 Return on assets 1.28% 1.10% 0.18 %pts.
21a Return on equity 14.56% 13.21% 1.35 %pts.
21b Return on equity - operating 14.56% 13.30% 1.26 %pts.
22 Tangible return on assets 1.39% 1.20% 0.19 %pts.
23a Tangible return on equity 15.84% 14.51% 1.33 %pts.
23b Tangible return on equity - operating 15.84% 14.61% 1.23 %pts.
24 Net interest margin (FTE) 4.61% 4.54% 0.07 %pts.
25 Non interest income/operating income (FTE) 18.2% 17.9% 0.3 %pts.
(excluding net security gains & branch disposition)
26 Efficiency ratio 49.7% 53.0% (3.3) %pts.
(excluding acquisition & unusual expenses
& intangible amortization)
------------------------------------------------------================================================================
Capital
------------------------------------------------------
27 Tier I leverage ratio 6.87% 6.66% 0.21 %pts.
28 Tangible equity / assets 5.65% 4.96% 0.69 %pts.
29 Accumulated other comprehensive income $43,728 $25,546 $18,182 71.2%
30 Diluted weighted average common shares outstanding 13,172 13,194 (22) -0.2%
31 Period end common shares outstanding 12,963 12,959 4 0.0%
32 Cash dividends declared per common share $0.29 $0.27 $0.02 7.4%
33 Common stock price $29.63 $32.25 ($2.62) -8.1%
34 Total return - last 12 months 11.8% 19.6% (7.8) %pts.
35 Book value $25.01 $23.04 $1.97 8.6%
36 Tangible book value $14.54 $12.52 $2.02 16.1%
------------------------------------------------------================================================================
Asset Quality Ratios
------------------------------------------------------
37 Loan loss reserve / 1.35% 1.36% (0.01) %pts.
loans outstanding
38 Nonperforming loans / 0.69% 0.64% 0.05 %pts.
loans outstanding
39 Loan loss reserve / 197% 214% (17) %pts.
nonperforming loans
40 Net charge-offs / 0.47% 0.81% (0.34) %pts.
average loans
41 Loan loss provision / 110% 96% 14 %pts.
net charge-offs
42 Nonperforming assets / 0.75% 0.74% 0.01 %pts.
loans outstanding + OREO
==================================================================
19
----------------------------------------------------------------
000's Omitted Three Months Ended
----------------------------------------------------------------------------------------------------------------------
Line Sep 30, Sep 30, Change Change
No. 2002 2001 Amount Percent
------------------------------------------------------================================================================
Asset Quality Components
------------------------------------------------------
43 Nonaccruing loans $10,928 $5,677 $5,251 92.5%
44 90+ days delinquent 1,289 2,842 (1,553) -54.6%
45 Total nonperforming loans 12,217 8,519 3,698 43.4%
46 Troubled debt restructurings 46 85 (39) -45.9%
47 Other real estate 1,033 1,835 (802) -43.7%
48 Total nonperforming assets 13,296 10,439 2,857 27.4%
49 Net charge-offs $2,080 $1,356 $724 53.4%
------------------------------------------------------================================================================
Components of Net Interest Margin (FTE)
------------------------------------------------------
50 Loan yield 7.45% 8.30% (0.85) %pts.
51 Investment yield 6.58% 6.86% (0.28) %pts.
52 Earning asset yield 7.08% 7.73% (0.65) %pts.
53 Interest bearing deposits rate 2.48% 4.06% (1.58) %pts.
54 Borrowed funds rate - FHLB 3.87% 5.40% (1.53) %pts.
55 Borrowed funds rate - Trust preferred & other 7.47% 8.80% (1.33) %pts.
56 Cost of all interest bearing funds 2.87% 4.45% (1.58) %pts.
57 Cost of funds (includes DDA) 2.46% 3.85% (1.39) %pts.
58 Cost of funds / earning assets 2.47% 3.79% (1.32) %pts.
59 Net interest margin (FTE) 4.61% 3.94% 0.67 %pts.
60 Full tax equivalent adjustment $3,229 $1,935 $1,294 66.9%
------------------------------------------------------================================================================
Average Balances for Period
------------------------------------------------------
61 Loans $1,763,855 $1,567,842 $196,013 12.5%
62 Investments & other interest bearing accounts 1,302,928 1,025,375 277,553 27.1%
(excluding market value adjustment)
63 Earning assets 3,066,783 2,593,217 473,566 18.3%
64 Total assets 3,438,076 2,835,584 602,492 21.2%
65 Deposits 2,542,233 2,076,447 465,786 22.4%
66 FHLB borrowings 468,563 413,518 55,045 13.3%
67 Trust preferred & other borrowings 77,632 66,502 11,130 16.7%
68 Total borrowings 546,195 480,020 66,175 13.8%
69 Total shareholders' equity $301,148 $238,159 $62,989 26.4%
================================================================
20
----------------------------------------------------------------
000's Omitted Nine Months Ended
----------------------------------------------------------------------------------------------------------------------
Line Six Months Ended June 30, 2002 Restated for SFAS 147 Sep 30, Sep 30, Change Change
No. 2002 2001 Amount Percent
----------------------------------------------------------------------------------------------------------------------
Asset Quality Components
------------------------------------------------------
43 Nonaccruing loans $10,928 $5,677 $5,251 92.5%
44 90+ days delinquent 1,289 2,842 (1,553) -54.6%
45 Total nonperforming loans 12,217 8,519 3,698 43.4%
46 Troubled debt restructurings 46 85 (39) -45.9%
47 Other real estate 1,033 1,835 (802) -43.7%
48 Total nonperforming assets 13,296 10,439 2,857 27.4%
49 Net charge-offs $7,001 $4,059 $2,942 72.5%
------------------------------------------------------================================================================
Components of Net Interest Margin (FTE)
------------------------------------------------------
50 Loan yield 7.55% 8.57% (1.02) %pts.
51 Investment yield 6.72% 6.99% (0.27) %pts.
52 Earning asset yield 7.20% 7.94% (0.74) %pts.
53 Interest bearing deposits rate 2.67% 4.35% (1.68) %pts.
54 Borrowed funds rate - FHLB 4.14% 5.56% (1.42) %pts.
55 Borrowed funds rate - Trust preferred & other 7.48% 9.26% (1.78) %pts.
56 Cost of all interest bearing funds 3.05% 4.69% (1.64) %pts.
57 Cost of funds (includes DDA) 2.61% 4.09% (1.48) %pts.
58 Cost of funds / earning assets 2.64% 4.06% (1.42) %pts.
59 Net interest margin (FTE) 4.56% 3.88% 0.68 %pts.
60 Full tax equivalent adjustment $8,744 $5,265 $3,479 66.1%
------------------------------------------------------================================================================
Average Balances for Period
------------------------------------------------------
61 Loans $1,746,719 $1,558,611 $188,108 12.1%
62 Investments & other interest bearing accounts 1,266,375 1,032,650 233,725 22.6%
(excluding market value adjustment)
63 Earning assets 3,013,094 2,591,261 421,833 16.3%
64 Total assets 3,371,805 2,837,812 533,993 18.8%
65 Deposits 2,544,079 2,068,995 475,084 23.0%
66 FHLB borrowings 420,895 459,404 (38,509) -8.4%
67 Trust preferred & other borrowings 77,864 42,472 35,392 83.3%
68 Total borrowings 498,759 501,876 (3,117) -0.6%
69 Total shareholders' equity $286,053 $230,465 $55,588 24.1%
==================================================================
21
----------------------------------------------------------------
000's Omitted Three Months Ended
--------------------------------------------------------------------------------------------------------------------------
Line Three Months Ended June 30, 2002 Restated for SFAS 147 Sep 30, Jun 30, Change Change
No. 2002 2002 Amount Percent
--------------------------------------------------------------------------------------------------------------------------
Asset Quality Components
----------------------------------------------------------
43 Nonaccruing loans $10,928 $10,029 $899 9.0%
44 90+ days delinquent 1,289 1,141 148 13.0%
45 Total nonperforming loans 12,217 11,170 1,047 9.4%
46 Troubled debt restructurings 46 59 (13) -22.0%
47 Other real estate 1,033 1,671 (638) -38.2%
48 Total nonperforming assets 13,296 12,900 396 3.1%
49 Net charge-offs $2,080 $3,512 ($1,432) -40.8%
----------------------------------------------------------================================================================
Components of Net Interest Margin (FTE)
----------------------------------------------------------
50 Loan yield 7.45% 7.43% 0.02 %pts.
51 Investment yield 6.58% 6.78% (0.20) %pts.
52 Earning asset yield 7.08% 7.15% (0.07) %pts.
53 Interest bearing deposits rate 2.48% 2.63% (0.15) %pts.
54 Borrowed funds rate - FHLB 3.87% 4.03% (0.16) %pts.
55 Borrowed funds rate - Trust preferred & other 7.47% 7.37% 0.10 %pts.
56 Cost of all interest bearing funds 2.87% 3.01% (0.14) %pts.
57 Cost of funds (includes DDA) 2.46% 2.58% (0.12) %pts.
58 Cost of funds / earning assets 2.47% 2.61% (0.14) %pts.
59 Net interest margin (FTE) 4.61% 4.54% 0.07 %pts.
60 Full tax equivalent adjustment $3,229 $2,986 $243 8.1%
----------------------------------------------------------================================================================
Average Balances for Period
----------------------------------------------------------
61 Loans $1,763,855 $1,742,110 $21,745 1.2%
62 Investments & other interest bearing accounts 1,302,928 1,296,787 6,141 0.5%
(excluding market value adjustment)
63 Earning assets 3,066,783 3,038,897 27,886 0.9%
64 Total assets 3,438,076 3,390,665 47,411 1.4%
65 Deposits 2,542,233 2,545,301 (3,068) -0.1%
66 FHLB borrowings 468,563 449,235 19,328 4.3%
67 Trust preferred & other borrowings 77,632 77,805 (173) -0.2%
68 Total borrowings 546,195 527,040 19,155 3.6%
69 Total shareholders' equity $301,148 $281,436 $19,712 7.0%
==================================================================
22
Results of Operations
Overview:
Third quarter 2002 net income was $11.1 million, up $4.6 million or 72% from the
same period last year. There were no non-recurring acquisition and other costs
this quarter versus $631,000 one year earlier. For the first nine months, net
income was $28.9 million, up 101.9% over last year. Earnings per share (diluted)
for the third quarter were $0.84, up 53% over the same 2001 period, while
earnings per share (diluted) for the first nine months were $2.19, up 78%.
These results include the benefit of adopting SFAS 147, an accounting standard
that eliminates the regular amortization of goodwill related to the Company's
branch acquisitions. This adoption increased third quarter and year-to-date
earnings per share by $0.07 and $0.21, respectively. Without this benefit, third
quarter earnings per share would have risen 40% and nine-month results would
have been up by 61%. The primary reasons for these substantial increases are
better earning asset margins over cost of funds and the improved contribution of
the Company's three 2001 acquisitions. Together, these transactions added $1.2
billion in assets and expanded the Company's branch network by 70% as of
year-end 2001.
Effective January 1, 2002, the Company adopted SFAS 142, "Goodwill and Other
Intangible Assets," which eliminated the requirement to regularly amortize
approximately $19.8 million in goodwill related to certain of its acquisitions.
Annual amortization expense was thus reduced by approximately $1.3 million;
$.015 of the increase in earnings per share (diluted) this quarter and $0.045
for the first nine months reflects the impact of this adoption. The Company
completed its goodwill impairment analysis during 2002, and no adjustment was
necessary.
The primary reasons for improved third quarter earnings compared to the same
period last year are a 36% increase in net interest income and a 15% rise in
noninterest income. The resulting higher operating income more than offset a
higher loan loss provision (reflective of a $724,000 or 53% increase in net
charge-offs) and increased overhead resulting from the acquisition of the former
FleetBoston branches in mid-November 2001. Year-to-date earnings were up versus
the comparable period last year for primarily the same reasons.
Proforma:
Performance as measured by operating earnings, which exclude expenses and
securities transactions related to acquisitions, is considered by some
securities analysts to be a more accurate reflection of the underlying core
earnings strength of a company. CBU's operating earnings per share (diluted) for
the third quarter were $0.84, up 45% from the prior year's level of $0.58, while
operating earnings per share (diluted) for the nine months were $2.23, up 44%.
Excluding the benefit of adopting SFAS 147, third quarter operating earnings per
share would have risen 33% to $0.77, and nine-month results would have been up
by 30% to $2.02.
CBU has also historically reported its performance using another measure of
earnings power--cash earnings. Now that SFAS 147 has been adopted, this metric
has been redefined to exclude from earnings the expense of regularly amortizing
core deposit intangibles (CDI). CDI represents the premium the Company has paid
for deposits acquired in excess of the cost incurred had the funds been
purchased in the capital markets. Amortization of CDI is a non-cash expense, and
adding it back (tax-adjusted) to reported earnings creates the cash earnings
metric. Cash earnings are believed to be a better measure of a Company's ability
to build capital, fund expansion, and pay shareholder dividends. CBU's cash
operating earnings per share (diluted) for the third quarter were $0.91, up 36%
from the prior year, while cash operating earnings per share (diluted) for the
nine months were $2.44, also up 36%.
23
Net Interest Income
Net interest income for third quarter 2002 rose to $32.4 million, 36% over the
same period last year. The improvement largely reflects improved margins and
higher earning asset levels. In particular, the market served by the former
FleetBoston branches contributed $172 million in commercial and consumer loans
and $504 million in low-cost core deposits as of September 30. While net run-off
of loans in that new market has approximated 3% since acquisition date, core
deposits have risen over 5%. The quarter also benefited from a build-up of the
investment portfolio earlier in the year and a $47 million increase in loans
outstanding over the past nine months. The net interest margin was 4.61%, up 67
basis points from the year-earlier level of 3.94%. The margin's low point was in
second quarter 2001 at 3.78%; it then widened for three consecutive quarters,
and has essentially leveled off during the last two quarters.
o The rise in margin reflects a slower decrease in earning asset yields than
in the cost of funds. Approximately 34% of earning assets reprice within
one year. Of total interest-bearing liabilities, 55% are regularly
repriced (maturing C.D.s, money market accounts, and certain borrowings)
and another 25% are repriced periodically (interest checking and savings).
Maturing certificates of deposit continued to reprice downward by 68 basis
points on average during the quarter, slowing from the 91- and
212-basis-point pace of the second and first quarter 2002, consistent with
lower financial market interest rates. The rate on total capital market
borrowings was reduced by 15 basis points during the third quarter. The
difference between the net interest spread of earning assets over
liabilities and the net interest margin has narrowed over the last four
quarters, primarily as a result of an increased proportion of
interest-bearing liabilities.
o Earning assets were 19% higher than one year earlier, comprised of $215
million more in loans and $273 million more in securities. Over the last
90 days, earning assets rose $31 million; loans increased by $28 million
while investments rose by $3 million. Growth in third quarter average
assets of $602 million compared to one year earlier was largely funded by
an increase in average retail and commercial deposits of $484 million, a
planned decrease in more volatile public fund deposits of $18 million, and
an increase in average borrowings of $66 million. Total borrowings as a
percent of earning assets ended the quarter at 17% versus 12% at year-end,
following the closing of the FleetBoston transaction, and 18% as of
September 30, 2001.
o The $3 million increase in investment securities this quarter reflects
partial reinvestment of proceeds from $52 million in securities sales
during the second quarter, which generated $1.1 million in gains.
Approximately $216,000 in gains was recognized in the third quarter on the
sale of $9.7 million in corporate bonds whose credit outlook had fallen to
the low end of policy guidelines. Investment portfolio purchases for the
third quarter were $57 million, down sharply from $86 million in the
second quarter and $199 million in the first. The purchases in the first
and second quarter, which were funded by short-term borrowings, reflected
attractive buying opportunities at that time both as to gross yield and as
a spread over borrowings, and represented an earnings strategy intended to
supplement the projected shortfall in loan growth compared to the
Company's initial 2002 goals. Since that purchase strategy was
implemented, gross yields on securities with the combination of maturity,
market value exposure, and interest rate characteristics that fit our
investment criteria have been diminishing.
o Third quarter net interest income exceeded the second quarter 2002 level
by $959,000, primarily reflective of loans booked in the last 90 days and
the investment securities adjustment noted above. An additional $336,000
in accrued income on a collateralized mortgage obligation was booked in
the third quarter. Had this entry not occurred, the third quarter net
interest margin would have been 4.57%, virtually the same as the 4.56%
margin in the second quarter as adjusted for reversal of certain loan
income and accretion of discount on a called investment security.
24
The following table sets forth certain information concerning average
interest-earning assets and interest-bearing liabilities and the yields and
rates thereon. Interest income and resultant yield information in the tables are
on a fully tax-equivalent basis using a marginal federal income tax rate of 35%.
Averages are computed on daily average balances for each month in the period
divided by the number of days in the period. Yields and amounts earned include
loan fees. Nonaccrual loans have been included in interest earning assets for
purposes of these computations.
Three Months Ended September 30,
---------------------------------------------------------------------
(000's omitted except yields and rates) 2002 2001
---------------------------------------------------------------------
Average Average
Average Amount Yield/Rate Average Amount Yield/Rate
Balance of Interest Paid Balance of Interest Paid
---------------------------------------------------------------------
ASSETS
Interest-earning assets:
Federal funds sold $ 0 $ 0 0.00% $ 16,928 $ 171 4.01%
Time deposits in other banks 839 1 0.47% 278 2 2.85%
Taxable investment securities 910,937 14,506 6.32% 784,524 13,348 6.75%
Nontaxable investment securities 391,152 7,108 7.21% 223,645 4,197 7.45%
Loans (net of unearned discount) 1,763,855 33,131 7.45% 1,567,842 32,808 8.30%
---------------------- --------------------
Total interest-earning assets 3,066,783 54,746 7.08% 2,593,217 50,526 7.73%
Noninterest earning assets:
Cash and due from banks 99,251 70,246
Premises and equipment 57,036 43,714
Other assets 195,759 125,876
Reserve for loan losses (23,900) (20,831)
Net unrealized gains on available-for-sale
portfolio 43,147 23,362
----------- ----------
Total assets $ 3,438,076 $2,835,584
=========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing liabilities:
Savings deposits $ 968,345 2,843 1.16% $ 651,672 3,036 1.85%
Time deposits 1,126,585 10,257 3.61% 1,078,799 14,653 5.39%
Short-term borrowings 173,954 830 1.89% 83,203 836 3.99%
Long-term borrowings 372,241 5,190 5.53% 396,817 6,257 6.26%
---------------------- --------------------
Total interest-bearing liabilities 2,641,125 19,120 2.87% 2,210,491 24,782 4.45%
Noninterest bearing liabilities:
Demand deposits 447,303 345,976
Other liabilities 48,500 40,958
Shareholders' equity 301,148 238,159
----------- ----------
Total liabilities and shareholders' equity $ 3,438,076 $2,835,584
=========== ==========
Net interest earnings $35,626 $25,744
======= =======
Net interest spread 4.21% 3.28%
Net interest margin on interest-earning assets 4.61% 3.94%
Federal tax exemption on nontaxable investment
Securities and loans included in interest income $ 3,229 $ 1,935
25
The change in net interest income (fully tax-equivalent basis) may be analyzed
by segregating the volume and rate components of the changes in interest income
and interest expense for each underlying category.
The volume and rate components of interest income and interest expense for each
underlying category are as follows:
- -------------------------------------------------------------------------------
3rd Quarter 2002 versus 3rd Quarter 2001
Increase (Decrease) Due to Change in (1)
---------------------------------------
Net
(000's omitted) Volume Rate Change
- -------------------------------------------------------------------------------
Interest earned on:
Federal funds sold ($86) ($86) ($171)
Time deposits in other banks 2 (3) (1)
Taxable investment securities 2,052 (894) 1,158
Nontaxable investment securities 3,048 (137) 2,911
Loans (net of unearned discount) 3,871 (3,548) 323
Total interest-earning assets (2) 8,697 (4,477) 4,220
Interest paid on:
Savings deposits 1,166 (1,359) (193)
Time deposits 624 (5,020) (4,396)
Short-term borrowings 589 (595) (6)
Long-term borrowings (372) (695) (1,067)
Total interest-bearing liabilities (2) 4,221 (9,883) (5,662)
Net interest earnings (2) $ 5,115 $ 4,767 $ 9,882
(1) The change in interest due to both rate and volume has been allocated to
volume and rate changes in proportion to the relationship of the absolute dollar
amounts of change in each.
(2) Changes due to volume and rate are computed from the respective changes in
average balances and rates of the totals; they are not a summation of the
changes of the components.
26
Noninterest Income
The following table sets forth information for noninterest income by category
for the periods indicated:
Three Months Ended September 30, Nine Months Ended Sept. 30,
---------------------------------------------------------------------------------
Change from 3Q '01 Change from 2Q '02
------------------ ------------------ Change Change
(000's omitted) 2002 Amount Percent Amount Percent 2002 Amount Percent
- -----------------------------------------------------------------------------------------------------------------------------------
Personal trust $ 376 ($96) -20.3% ($64) -14.5% $1,330 ($78) -5.5%
EBT/BPA 1,123 92 8.9% 28 2.6% 3,321 524 18.7%
Elias Asset Management 627 (277) -30.6% (158) -20.1% 2,190 (708) -24.4%
CISI 709 115 19.4% (449) -38.8% 3,059 1,289 72.8%
Insurance - CBNA 854 167 24.3% 782 1086.1% 981 182 22.8%
- -----------------------------------------------------------------------------------------------------------------------------------
Total financial services 3,689 1 0.0% 139 3.9% 10,881 1,209 12.5%
Electronic banking 618 265 75.1% 72 13.2% 1,770 717 68.1%
Mortgage banking (47) (133) -154.7% (113) -171.2% 138 (226) -62.1%
Commercial leasing 1 (12) -92.3% (4) -80.0% 9 (25) -73.5%
Deposit service charges 1,371 307 28.9% 39 2.9% 4,017 797 24.8%
Overdraft fees 1,736 426 32.5% 154 9.7% 4,750 1,109 30.5%
Commissions 510 60 13.3% 10 2.0% 1,624 25 1.6%
Miscellaneous revenue (6) (23) -135.3% 8 -57.1% (15) (19) -475.0%
- -----------------------------------------------------------------------------------------------------------------------------------
Total general banking services 4,183 890 27.0% 166 4.1% 12,293 2,378 24.0%
- -----------------------------------------------------------------------------------------------------------------------------------
Total noninterest income excluding
Investment security gain (loss), net
and disposition of branch properties 7,872 891 12.8% 305 4.0% 23,174 3,587 18.3%
Investment security gain (loss), net 216 (2,472) -92.0% (928) -81.1% 1,359 (1,200) -46.9%
Disposition of branch properties 0 0 0.0% 0 0.0% 0 0 0.0%
- -----------------------------------------------------------------------------------------------------------------------------------
Total noninterest income $ 8,088 ($1,581) -16.4% ($623) -7.2% $ 24,533 $ 2,387 10.8%
===================================================================================================================================
Noninterest income as a percentage of operating
income (excludes investment security gain
(loss), net and other timing adjustments) 18.2% -3.1% 0.3% 18.1% -2.5%
Third quarter financial services revenue at $3.7 million was unchanged compared
to third quarter last year, but up $139,000 or 3.9% from the second quarter 2002
level.
o The primary source of improvement over the linked quarter and maintenance
of the year ago level was receipt of the Company's annual dividend on its
creditor life insurance program managed by a subsidiary of the New York
Bankers Association. The dividend reached an all-time high of $750,000
compared to $617,000 one year earlier. Compared to third quarter 2001,
growth in the creditor life dividend and in revenues from the Company's
Benefit Plans Administrative Services (BPA) subsidiary (up 9% due to a
steady rise in plan sponsors) and broker-dealer, Community Investment
Services, Inc. (CISI, up 19%) equally offset reductions of 20% from
personal trust and 31% at Elias Asset Management. The success of CISI
reflects an expanded number of financial consultants and a significant
increase in branch referrals to the consultants. Third quarter 2002
financial services revenue was above second quarter 2002 due to the record
dividend. Significant third quarter declines at CISI, personal trust and
Elias were mostly a result of unfavorable equity market conditions. CISI
was also adversely affected by substantial reductions in the interest
rates being offered on annuity products for which they act as agent.
o Financial services revenue comprised 47% of total recurring noninterest
income for the quarter versus 53% one year earlier. The decrease was
caused by increased overdraft and deposit service charge income from the
former FleetBoston accounts acquired in mid-
27
November 2001; in contrast, the financial services accounts held by the
FleetBoston customers were not offered as part of the acquisition package.
o Assets under management were $1.267 billion as of quarter end, a 7.5%
reduction from the June 30, 2002 level. This decrease reflects a
double-digit reduction in assets under management at EAM, which
historically has invested in large capitalization growth stocks, partially
offset by lesser decreases in the Bank's personal trust department and
broker-dealer, reflective of the more balanced nature of their portfolios.
In contrast, strong new business generation at BPA resulted in an increase
in assets under management of $11.7 million or 3.2%. Compared to September
30, 2001, assets under management are higher by $30 million or 2.4%,
reflective of growth at BPA and personal trust, a very respectable figure
when compared to many broad market indicators, including a 22% decline in
the Standard & Poor's 500 equity market index.
General banking revenues were $4.2 million for the quarter, up 27% or $890,000
over the same period last year and up 4.1% or $166,000 from second quarter 2002.
o A primary reason for the improvement over prior year was the contribution
of the acquired FleetBoston branches, largely in deposit service charges
and overdraft fees. Bank-wide these items rose a combined 31% or $733,000
compared to third quarter 2001. While deposit service charges were up
slightly over second quarter 2002, overdraft fees increased 9.7% or
$154,000 due to an increase in the customer insufficient funds charge and
higher volumes, which in part reflected a better collection rate.
o Electronic banking revenues climbed 75% or $265,000 in the quarter
compared to one year earlier, mirroring the higher customer base due to
2001's acquisitions and greater product usage, and increased 13% or
$72,000 over the second quarter 2002 level.
o Mortgage banking fees were slightly negative for the quarter because of a
$115,000 write-down of mortgage servicing rights (approximately 21% of the
value at June 30, 2002) due to accelerated mortgage prepayments caused by
record refinancing. The rights are presently 0.39% of the $104 million
serviced portfolio outstanding, which has been running down because of
prepayments and the decision to suspend sale of secondary market-eligible
production as of late fall last year. Fees from servicing mortgages
previously sold on the secondary market are a relatively minor activity
for the Company at this time.
The ratio of noninterest income to operating income (FTE) was 18.2% for third
quarter 2002, down 3.1 percentage points from the same period last year. In
part, the decreases reflect the unusually large 38% increase in net interest
income (FTE) caused by higher earning assets and improved margins. In addition,
the added revenues from cross selling financial services from the 2001
acquisitions have not yet been fully realized. The ratio rose a slight 0.3% from
second quarter 2002 because of the annual receipt of the Company's creditor life
insurance dividend. The Company remains committed to its long-standing objective
of increasing noninterest income and its proportionate share of operating
revenues.
28
The following table reconciles differences between the line of business
noninterest income breakdown and regulatory reporting definitions as reflected
on the Call Report.
Nine Months Ended September 30, 2002
--------------------------------------------------------------------------------------------
Regulatory Reporting Categories
--------------------------------------------------------------------------------------------
Other Service
Fiduciary and Service Charges Commissions Charges, Other Investment Total
Investment on Deposit on Investment Commissions Operating Security Gain Other
(000's omitted) Services Accounts Products and Fees Income (Loss), net Income
- ----------------------------------------------------------------------------------------------------------------------------------
Personal trust $1,330 $1,330
EBT/BPA 1,154 2,167 3,321
Elias Asset Management 2,190 2,190
CISI 3,059 3,059
Insurance - CBNA 981 981
- ----------------------------------------------------------------------------------------------------------------------------------
Total financial services 2,484 0 5,249 3,148 0 0 10,881
Electronic banking 617 1,152 1,769
Mortgage banking 132 6 138
Commercial leasing 9 9
Deposit service charges 4,017 4,017
Overdraft fees 4,750 4,750
Commissions 1,624 1,624
Miscellaneous revenue (14) (14)
- ----------------------------------------------------------------------------------------------------------------------------------
Total general banking services 0 9,384 0 2,917 (8) 0 12,293
Total noninterest income excluding
Investment security gain (loss), net
And disposition of branch
properties 2,484 9,384 5,249 6,065 (8) 0 23,174
Investment security gain (loss), net 1,359 1,359
- ----------------------------------------------------------------------------------------------------------------------------------
Total noninterest income $2,484 $9,384 $5,249 $6,065 ($8) $1,359 $24,533
==================================================================================================================================
29
Noninterest Expense
Third quarter noninterest expense of $23.1 million was $2.7 million or 13.2%
higher than the equivalent 2001 period. Noninterest expense of $71.8 million for
the nine months ending September 2002 was up $6.7 million or 10.4% compared to
the previous year. Excluding acquisition and unusual expenses, third quarter
noninterest expense was up $3.3 million or 16.8% versus the prior year.
September year-to-date noninterest expense of $71.1 million excluding
acquisition and unusual expenses was $12.2 million or 20.6% higher than the same
period of 2001. The quarterly and year-to-date increases were primarily a result
of the acquisition of the FleetBoston branches in mid-November of 2001. These
increases must be placed in context with 19% growth in earning assets and 32%
growth in operating income over the last four quarters.
The following table sets forth information for noninterest expenses by category
for the periods indicated.
Three Months Ended September 30, Nine Months Ended Sept. 30,
------------------------------------------------------------------------------------
Change from 3Q '01 Change from 2Q '02
------------------ ------------------ Change Change
(000's omitted) 2002 Amount Percent Amount Percent 2002 Amount Percent
- --------------------------------------------------------------------------------------------------------------------------
Personnel expense $12,020 $2,141 21.7% ($245) -2.0% $36,411 $6,090 20.1%
Net occupancy expense 1,781 317 21.7% (295) -14.2% 6,179 1,625 35.7%
Equipment expense 1,714 196 12.9% (270) -13.6% 5,569 1,153 26.1%
Legal and professional fees 845 100 13.4% 164 24.1% 2,380 317 15.4%
Data processing expense 1,813 473 35.3% 70 4.0% 5,234 1,419 37.2%
Amortization of intangibles 1,597 56 3.6% 93 6.2% 4,641 99 2.2%
Stationary and supplies 458 (43) -8.6% (152) -24.9% 1,756 352 25.1%
Foreclosed property expense 111 (104) -48.4% (179) -61.7% 730 (21) -2.8%
Deposit insurance premiums 106 9 9.3% (3) -2.8% 336 81 31.8%
Other 2,624 174 7.1% (85) -3.1% 7,861 1,048 15.4%
- -------------------------------------------------------------------------------------------------------------------------
Total before one-time expenses 23,069 3,319 16.8% (902) -3.8% 71,097 12,163 20.6%
Acquisition and unusual expenses 0 (631) -100.0% (108) -100.0% 700 (5,417) -88.6%
- -------------------------------------------------------------------------------------------------------------------------
Total noninterest expense $23,069 $2,688 13.2% ($1,010) -4.2% $71,797 $6,746 10.4%
=========================================================================================================================
Total operating expenses as
a percentage of average assets 2.66% -0.19% -0.16% 2.85% -0.22%
Efficiency ratio 49.7% -5.9% -3.3% 52.9% -4.4%
Third quarter personnel expense was up $2.1 million or 21.7% from third quarter
2001 levels, accounting for 65% of the increase in noninterest expense excluding
acquisition and unusual expenses. Total full-time equivalent staff at the end of
September 2002 was 1,124, up 191 from the end of September 2001 as a result of
the branches acquired from FleetBoston and the impact of the acquisition on
selected back office and administrative staffing requirements. These staffing
increases also caused year-to-date personnel expense to rise $6.1 million or
20.1% versus the prior year.
30
Third quarter non-personnel expense excluding acquisition and unusual expenses
was $1.2 million or 11.9% higher than the prior year period. The increase was
mostly attributable to data processing expenses, up $473,000 or 35.3%; occupancy
expense, up $317,000 or 21.7%; and equipment expense, up $196,000 or 12.9%.
Occupancy expenses were higher primarily as a result of the impact of the
FleetBoston branches acquired. Increased data processing expenses were mainly
due to higher Fiserv processing fees (the Company outsources its main-frame
system), Federal Reserve Bank check processing expenses and data line charges,
all reflective of greater processing volumes and communications costs of the
acquired FleetBoston branches. The rise in third quarter equipment expenses was
largely a result of higher depreciation due to the increased number of branches
in 2002. Higher occupancy, data processing and equipment expenses were also the
primary causes for the year-to-date non-personnel expense increase of $6.1
million or 21.2%, excluding acquisition and unusual expenses. Administrative
expenses such as office supplies, postage and telephone charges also contributed
to the higher expense level, again reflecting the additional number of branches
and employees arising from the FleetBoston transaction.
Third quarter operating expenses excluding acquisition and unusual expenses were
$902,000 or 3.8% below the level of second quarter 2002. Overhead in the banking
segment of the Company in third quarter 2002 was $850,000 lower than it was in
the prior 90 days. This reduction reflects seasonality, lower write-down of
repossessed property, and favorable expense variances. Financial services
overhead decreased from the second quarter level due to lower commission expense
on reduced sales.
The Company's efficiency ratio, which excludes intangible amortization, net
securities gains/losses, acquisition costs, and unusual income and expense
items, was an historically low 49.7% for third quarter 2002, resulting in a
5.9-percentage-point improvement from the comparable 2001 quarter and a
3.3-percentage-point decrease from second quarter 2002.
o The year-over-year change reflects the full impact of combined $3.2
million in First Liberty cost savings implemented in mid-second quarter
2001 and the benefit of streamlining our operations functions by
eliminating duplicate loan and deposit processing units in Canton and
Olean, N.Y. The improvement over second quarter 2002 resulted from the
expense reductions discussed above as well as the record annual dividend
in the third quarter on the Company's creditor life insurance program.
o There were no acquisition and unusual expenses in the third quarter (by
definition, they are excluded from the efficiency ratio calculation). For
the first nine months, these one-time costs totaled $700,000 in contrast
to $6.1 million for the same period last year.
Income Taxes
The effective income tax rate was 27.0% for the third quarter and 27.0% for the
nine months ending September 30, 2002, 0.3 and 2.0 percentage points below the
prior year periods, respectively. These reductions were due to a higher
percentage of income being derived from tax-exempt securities and other tax
planning strategies.
31
Financial Condition
Cash and Investments
Cash and investments were $1.460 billion at the end of the third quarter, an
increase of $205 million or 16.4% from the balances at December 31, 2001.
Average cash and investments of $1.445 billion for the third quarter were up
$242 million or 20.1% from the fourth quarter of 2001 and $343 million or 31.1%
from third quarter 2001 levels. The investment portfolio was increased in 2002,
especially earlier in the year, to take advantage of attractive buying
opportunities in terms of gross yield and spread over borrowings, and to offset
some of the projected shortfall in loan growth resulting from soft economic
conditions in many of our primary markets.
September 30, 2002 December 31, 2001
Amortized Estimated Fair Amortized Estimated Fair
(000's omitted) Cost Value Cost Value
- -----------------------------------------------------------------------------------------------------------------------------------
Amount Mix % Amount Mix % Amount Mix % Amount Mix %
------ ----- ------ ----- ------ ----- ------ -----
Held to Maturity Portfolio
Obligations of states and political subdivisions $ 7,476 100% $ 7,869 100% $ 7,608 100% $ 7,832 100%
Available for Sale Portfolio
U.S. treasury securities and agency obligations 382,953 30% 412,067 31% 192,111 17% 203,501 18%
Obligations of states and political subdivisions 405,522 32% 429,409 32% 282,110 25% 277,593 24%
Corporate securities 33,092 3% 36,619 3% 43,392 4% 44,399 4%
Collateralized mortgage obligations 273,628 21% 284,837 21% 400,100 36% 403,780 35%
Mortgage-backed securities 149,497 12% 154,983 11% 173,978 15% 179,786 16%
FHLB stock and other equity securities 25,821 2% 25,821 2% 25,863 2% 25,863 2%
Federal Reserve Bank common stock 5,652 0% 5,652 0% 5,652 1% 5,652 1%
- ----------------------------------------------------------------------------------------------------------------------------------
Total available for sale investments 1,276,165 100% $1,349,388 100% 1,123,206 100% $1,140,574 100%
Net unrealized gain on available for sale investments 73,222 17,368
---------- ----------
GRAND TOTAL CARRYING VALUE $1,356,863 $1,148,182
========== ==========
The mix of securities in the investment portfolio was altered during the first
nine months of 2002 as part of an overall investment strategy to further protect
net interest income in a falling rate environment. CMOs and corporate bonds were
sold, and U.S. agency and municipal securities were purchased. The net
unrealized gain on the investment portfolio has grown by $55.9 million through
September 30, 2002 due to market price appreciation caused by declining interest
rates. See further discussion of the investment purchases in the "Net Interest
Income" section above.
Loans
Loans ended the third quarter at $1.779 billion, up $215 million or 13.7% from
September 30, 2001. The improvement reflects the contribution of the acquired
FleetBoston branch loans as well as consumer loan growth largely in the
Company's long-standing markets. Compared to December 31, 2001, total loans have
increased by $47 million, reflecting an $8 million contraction in the first
quarter followed by growth in the second and third quarters of $27 million and
$28 million, respectively, or a combined 3.2% over the last six months.
Excluding the impact of acquisitions, this quarter's increase was the largest
since second quarter 2000.
o Business lending decreased $2 million during the last 90 days following a
$7 million drop in the second quarter and a $6 million drop in the first.
With the exception of acquisitions, commercial loan growth has been
relatively flat for the last two years, reflective of reduced business
activity in our markets due to economic softness, the desire to maintain
credit quality, and use of commercial lenders in evaluating and
integrating acquisitions versus developing new business. Though commercial
loan production in the overall New York
32
franchise remains off, outstandings have been climbing slightly in the
Northeastern Pennsylvania market (the Bank's First Liberty subsidiary)
over the last six months. Business loan outstandings at quarter end were
$629 million (35% of total loans outstanding).
o Consumer direct loans increased slightly over $1 million in the third
quarter following an over $9 million climb during the second quarter. This
growth, compared to a $19 million decrease in first quarter 2002, reflects
the impact of the Company's spring marketing program to homeowners, which
included promotional rates on home equity loans and direct installment
loans. Run-off in the portfolio due to regular repayments was stemmed in
the New York markets but was relatively unchanged in the First Liberty
market. Consumer direct loans ended the quarter at $388 million (22% of
total loans outstanding).
o Consumer indirect loans, largely borrowing originated in automobile dealer
showrooms, rose $11 million during the third quarter following increases
of $15 million and $5 million in the second and first quarters,
respectively. Both the New York and Pennsylvania markets contributed
growth, and new originating dealers have also been added. Overall, used
vehicles constitute 75% of CBU's indirect automobile loans outstanding.
Indirect loans at quarter end were $280 million (16% of total loans
outstanding).
o Consumer mortgages rose $17 million over the last 90 days, the greatest
increase this year after rising $9 million in the second quarter and $12
million in the first. This rise reflects the Company's spring homeowner
marketing campaign, the most favorable refinancing environment seen in
decades, and the Company's strategy for the last nine months to book
secondary-market-eligible loans in portfolio, made possible because of the
increase in core deposit funding from the FleetBoston branch acquisition.
Over the last twelve months, consumer mortgages have increased $39 million
or 9% to $482 million (27% of total loans outstanding).
33
The amounts of the Company's loans outstanding (net of deferred loan fees or
costs) at the dates indicated are shown in the following table according to type
of loan:
- ---------------------------------------------------------------------------------------
As of September 30,
------------------------------------------
Change Change
(000's omitted) 2002 2001 Amount Percent
- ---------------------------------------------------------------------------------------
Real estate mortgages:
Residential $ 737,858 $ 599,079 $ 138,779 23.2%
Commercial loans secured by real estate 271,354 263,130 8,224 3.1%
Farm 22,034 21,507 527 2.5%
- ---------------------------------------------------------------------------------------
Total 1,031,246 883,716 147,530 16.7%
Commercial, financial, and agricultural:
Commercial and financial 255,859 236,205 19,654 8.3%
Agricultural 26,650 25,829 821 3.2%
- ---------------------------------------------------------------------------------------
Total 282,509 262,034 20,475 7.8%
Installment loans to individuals 434,683 386,863 47,820 12.4%
Other loans 31,139 32,442 (1,303) -4.0%
- ---------------------------------------------------------------------------------------
Gross loans 1,779,577 1,565,055 214,522 13.7%
Less: unearned discount 137 249 (112) -45.0%
- ---------------------------------------------------------------------------------------
Net loans 1,779,440 1,564,806 214,634 13.7%
Allowance for loan losses 24,080 21,083 2,997 14.2%
- ---------------------------------------------------------------------------------------
Loans, net of allowance for loan losses $1,755,360 $1,543,723 $ 211,637 13.7%
=======================================================================================
The following table reconciles the differences between the line of business loan
breakdown reflected in the narrative of this report as compared to regulatory
reporting definitions reflected on the Call Report.
- -----------------------------------------------------------------------------------------
Line of Business as of September 30, 2002
-------------------------------------------------------
Consumer Consumer Consumer Business Total
(000's omitted) Direct Indirect Mortgages Lending Loans
- -----------------------------------------------------------------------------------------
Regulatory Reporting Categories:
Loans secured by real estate:
Residential $225,414 $ 0 $479,979 $ 32,465 $ 737,858
Commercial 46 0 2,032 269,276 271,354
Farm 33 0 22,001 22,034
Agricultural loans 356 0 26,294 26,650
Commercial loans 14,041 0 241,818 255,859
Installment loans to individuals 145,861 280,345 105 8,372 434,683
Other loans 2,258 0 28,881 31,139
- -----------------------------------------------------------------------------------------
Total loans 388,009 280,345 482,116 629,107 1,779,577
Unearned discount 137 0 0 0 137
- -----------------------------------------------------------------------------------------
Net loans $387,872 $280,345 $482,116 $629,107 $1,779,440
=========================================================================================
Asset Quality
Asset quality as of September 30, 2002 reflects increased nonaccruing loans from
one year ago, largely isolated to three commercial loans added during first and
second quarter 2002, and a higher number of real estate mortgages added
gradually throughout the period. Overall, nonperforming loans (including 90-day
delinquencies) have risen $3.7 million or 43% over the last 12 months, and $1.0
million or 9% in the last 90 days. As a percent of loans outstanding,
nonperforming loans were 0.69% at quarter end compared to 0.54% one year earlier
and 0.64% at June 30, 2002.
34
Net charge-offs for the third quarter were $2.1 million compared to $1.4 million
one year ago; they were down significantly from $3.5 million in second quarter
2002. For the last 12 months, quarterly net charge-offs have averaged $2.4
million compared to $1.6 million for the preceding 12-month period.
o The primary reason for the overall increase in charge-offs is the impact
of the softening economy on certain of our commercial borrowers, including
two aforementioned larger customers in the second quarter of this year.
Until the economy begins to strengthen, it is difficult to estimate
whether the current 12-month run-rate for commercial net charge-offs of
$1.3 million per quarter will move closer to its average of the prior
12-month period of about $500,000 per quarter.
o Consumer installment net charge-offs have averaged $1.0 million per
quarter since September 30, 2001, virtually unchanged from the preceding
12-month period. Consumer mortgage charge-offs continue to be historically
de minimus. The upturn in real estate nonperformers noted above may be a
reflection of overall weaker economic conditions.
o Total net charge-offs for the first nine months of the year were $7.0
million, up $2.9 million or 73%, reflecting higher commercial loan
write-offs as discussed above.
o All net charge-off ratios stated below are on annualized basis. As a
percent of average loans outstanding, net charge-offs for the third
quarter were 0.47%, well within the range of the trailing four quarters of
0.33% - 0.81%. Consistent with the recently higher level of net
charge-offs, the average quarterly rate for the last 12 months at 0.56%
exceeded that for the preceding 12-month period of 0.41%. Year-to-date,
net charge-offs have averaged 0.54% of outstandings versus 0.35% in 2001.
The sole cause of the increase was commercial net charge-offs; as a
percent of related outstandings for the first nine months of this year,
they averaged 0.78% versus 0.17% for the comparable 2001 period. In
contrast, consumer installment loans have averaged 0.89% this year, an
improvement over 1.00% for full year 2001. Mortgage and home equity net
charge-offs have been negligible.
Regular bottom-up review of the asset quality of the portfolio is completed each
quarter. Specific loan loss allocations for certain identified commercial
customers are considered and revised as necessary, and charge-offs are taken
against these reserves before being applied against the general reserve. General
allocations against non-criticized commercial loans and the consumer product
lines are reviewed and recalculated quarterly based on historical loss
experience, performance trends, and various quantifiable judgement factors. As a
result of this process, a required loan loss reserve of $24.1 million was
determined as of September 30, 2002, resulting in a $2.3 million loan loss
provision compared to $1.6 million in third quarter 2001 and $3.4 million in
second quarter 2002. This provision represented 110% of net charge-offs,
bringing year-to-date coverage to 103%, down slightly from 106% last year at
this time.
As noted above, nonperforming loans (loans 90 days past due and non-accruing)
were 0.69% as a percent of loans outstanding at quarter end versus 0.54% one
year earlier. Though higher than a year ago, the level of this ratio compared
favorably with the peer bank median at June 30, 2002, which was 0.95% versus the
Company's ratio of 0.64% at that time. Peer bank coverage of the reserve over
nonperformers, a general comparative measure of reserve adequacy, was 202% as of
the same date, less than the Company's coverage ratio of 214%. The Company's
coverage ratio decreased slightly during the third quarter to 197%, for which no
comparable peer data is yet available.
Delinquent loans (30 days through nonaccruing) as a percent of total
outstandings increased a slight three basis points during the last 90 days to
1.80%. This compares to 1.96% one year ago, after which the ratio steadily fell
for three consecutive quarters.
35
The following table presents information concerning the aggregate amount of
nonperforming assets:
- ------------------------------------------------------------------------------------------------
As of September 30,
---------------------------------------
Change Change
(000's omitted) 2002 2001 Amount Percent
- ------------------------------------------------------------------------------------------------
Loans accounted for on a nonaccrual basis $10,928 $ 5,677 $ 5,251 92.5%
Accruing loans which are contractually past due 90
days or more as to principal or interest payments 1,289 2,842 (1,553) -54.6%
- ------------------------------------------------------------------------------------------------
Total nonperforming loans 12,217 8,519 3,698 43.4%
Restructured loans 46 85 (39) -45.9%
Other real estate 1,033 1,835 (802) -43.7%
- ------------------------------------------------------------------------------------------------
Total non performing assets $13,296 $10,439 $ 2,857 27.4%
================================================================================================
Ratio of allowance for loan losses to period-end loans 1.35% 1.35% 0.00%
Ratio of allowance for loan losses to period-end
nonperforming loans 197.1% 247.5% -50.4%
Ratio of allowance for loan losses to period-end
nonperforming assets 181.1% 202.0% -20.9%
Ratio of nonperforming loans to period-end loans 0.69% 0.54% 0.15%
Ratio of nonperforming assets to period-end total
loans and other real estate 0.75% 0.67% 0.08%
The impact of interest not recognized on nonaccrual loans, and interest income
that would have been recorded if the restructured loans had been current in
accordance with their original terms, was immaterial. The Company's policy is to
place a loan on a nonaccrual status and recognize income on a cash basis when it
is more than ninety days past due, except when in the opinion of management it
is well secured and in the process of collection.
36
The following table summarizes loan balances at the end of each period indicated
and the daily average amount of loans. Also summarized are changes in the
allowance for loan losses arising from loans charged off and recoveries on loans
previously charged off and additions to the allowance, which have been charged
to expenses.
Three Months Ended September 30, Nine Months Ended September 30,
-----------------------------------------------------------------------------------------
Change Change Change Change
(000's omitted) 2002 2001 Amount Percent 2002 2001 Amount Percent
- -----------------------------------------------------------------------------------------------------------------------------------
Amount of loans outstanding at
end of period $1,779,440 $1,564,806 $214,634 13.7% $1,779,440 $1,564,806 $214,634 13.7%
- ----------------------------------------------------------------------------------------------------------------------------------
Daily average amount of loans
(net of unearned discount) 1,763,855 1,567,842 196,013 12.5% 1,746,719 1,558,611 188,108 12.1%
- ----------------------------------------------------------------------------------------------------------------------------------
Balance of allowance for loan
losses at beginning of period 23,883 20,860 3,023 14.5% 23,901 20,035 3,866 19.3%
Loans charged off:
Commercial, financial, and agricultural 864 128 736 575.0% 4,021 1,015 3,006 296.2%
Real estate 84 21 63 300.0% 84 117 (33) -28.2%
Installment 1,642 1,612 31 1.9% 4,654 4,443 211 4.7%
- ----------------------------------------------------------------------------------------------------------------------------------
Total loans charged off 2,590 1,761 830 47.1% 8,759 5,575 3,184 57.1%
Recoveries of loan previously charged off:
Commercial, financial and agricultural 53 27 26 96.3% 248 259 (11) -4.2%
Real estate 11 4 7 175.0% 117 55 62 112.7%
Installment 446 374 72 19.3% 1,393 1,202 191 15.9%
- ----------------------------------------------------------------------------------------------------------------------------------
Total recoveries 510 405 105 25.9% 1,758 1,516 242 16.0%
- ----------------------------------------------------------------------------------------------------------------------------------
Net loans charged off 2,080 1,356 725 53.5% 7,001 4,059 2,942 72.5%
Provision for loan losses 2,278 1,579 699 44.3% 7,180 4,320 2,860 66.2%
Reserve on acquired loans (1) 0 0 0 0.0% 0 787 (787) -100.0%
- ----------------------------------------------------------------------------------------------------------------------------------
Balance of allowance for loan losses
at end of period $ 24,080 $ 21,083 $ 2,997 14.2% $ 24,080 $ 21,083 $ 2,997 14.2%
==================================================================================================================================
Ratio of net charge-offs to average
loans outstanding 0.47% 0.34% 0.13% 0.54% 0.35% 0.19%
(1) This reserve addition is attributable to loans purchased from Citizens
National Bank of Malone.
Deposits
Total deposits at September 30, 2002 were $2.552 billion, $6 million or 0.2%
above the balance at year-end 2001. Third quarter average total deposits of
$2.542 billion remained essentially flat with the average for the second quarter
of 2002.
September December Change Change
(000's omitted) 30, 2002 31, 2001 Amount Percent
- -------------------------------------------------------------------------------
Noninterest-bearing demand deposits $ 450,131 $ 447,544 $2,587 0.6%
Interest-bearing demand deposits 256,976 259,141 (2,165) -0.8%
Regular savings deposits 412,070 378,065 34,005 9.0%
Money market deposits 306,901 291,375 15,526 5.3%
Time deposits 1,125,657 1,169,845 (44,188) -3.8%
- -------------------------------------------------------------------------------
Total deposits $2,551,735 $2,545,970 $5,765 0.2%
===============================================================================
IPC deposits $2,390,578 $2,394,395 ($3,817) -0.2%
Public fund deposits 161,157 151,575 9,582 6.3%
- -------------------------------------------------------------------------------
Total deposits $2,551,735 $2,545,970 $5,765 0.2%
===============================================================================
Increases in checking, savings and money market account balances over the past
nine months have neutralized run-off of time deposit balances. This shift in
customer account balances may be reflective of lower yield spreads between CD
and other interest bearing accounts,
37
less willingness of consumers to be locked into rates for longer terms given the
low interest rate environment and its expected duration, and less attention to
managing down checking account balances due to low opportunity cost.
Borrowings
At the end of the third quarter, borrowings and federal funds purchased of $451
million were $173 million or 62% higher than they were at the end of 2001.
Short-term borrowings increased by $201 million, long-term borrowings decreased
by $25 million and federal funds purchased were reduced by $3 million. The
additional borrowing was primarily used to fund the growth of the investment
portfolio in order to take advantage of favorable interest rate spreads caused
by the steep Treasury yield curve.
Other Assets and Liabilities
Other assets and liabilities had a net liability balance of $27.309 million at
the end of the second quarter versus a net liability position of $12.806 million
at December 31, 2001. The change was mainly attributable to an increase in
deferred taxes related to the market value adjustment and assorted timing
differences.
Shareholders' Equity
Total shareholders' equity equaled $324.2 million at the end of the third
quarter, $56.2 million higher than the balance at December 31, 2001. This
increase consisted of $1.6 million from shares issued under the employee stock
plan, an after-tax market value adjustment of $33.4 million, an after-tax
minimum pension liability adjustment of $3.0 million and net income of $28.9
million, offset by dividends declared of $10.7 million.
Liquidity
Due to the potential for unexpected fluctuations in deposits and loans, active
management of the Company's liquidity is critical. In order to respond to these
circumstances, adequate sources of additional deposits, borrowings and available
lines of credit are in place.
CBU's primary approach to measuring liquidity is known as the Basic
Surplus/Deficit model. It is used to calculate liquidity over two time periods:
first, the relationship within 30 days between liquid assets and short-term
liabilities which are vulnerable to nonreplacement; and second, a projection of
subsequent cash availability over an additional 60 days. The minimum policy
level of liquidity under the Basic Surplus/Deficit approach is 7.5% of total
assets for both the 30 and 90-day time horizons. As of September 30, 2002, this
ratio was 17.2% and 17.7%, respectively, excluding the Company's capacity to
borrow additional funds from the Federal Home Loan Bank. Including this latter
capacity, the 30 and 90-day ratios are 24.9% and 25.4%, respectively. The
Company considers liquidity adequate to meet its operating needs for the
foreseeable future.
38
Forward-Looking Statements
This document contains comments or information that constitute forward-looking
statements (within the meaning of the Private Securities Litigation Reform Act
of 1995), which involve significant risks and uncertainties. Actual results may
differ materially from the results discussed in the forward-looking statements.
Moreover, the Company's plans, objectives and intentions are subject to change
based on various factors (some of which are beyond the Company's control).
Factors that could cause actual results to differ from those discussed in the
forward-looking statements include: (1) risks related to credit quality,
interest rate sensitivity and liquidity; (2) the strength of the U.S. economy in
general and the strength of the local economies where the Company conducts its
business; (3) the effect of, and changes in, monetary and fiscal policies and
laws, including interest rate policies of the Board of Governors of the Federal
Reserve System; (4) inflation, interest rate, market and monetary fluctuations;
(5) the timely development of new products and services and customer perception
of the overall value thereof (including features, pricing and quality) compared
to competing products and services; (6) changes in consumer spending, borrowing
and savings habits; (7) technological changes; (8) any acquisitions or mergers
that might be considered by the Company and the costs and factors associated
therewith; (9) the ability to maintain and increase market share and control
expenses; (10) the effect of changes in laws and regulations (including laws and
regulations concerning taxes, banking, securities and insurance) and accounting
principles generally accepted in the United States; (11) changes in the
Company's organization, compensation and benefit plans and in the availability
of, and compensation levels for, employees in its geographic markets; (12) the
costs and effects of litigation and of any adverse outcome in such litigation;
and (13) the success of the Company at managing the risks of the foregoing.
The foregoing list of important factors is not all-inclusive. Such
forward-looking statements speak only as of the date on which they are made and
the Company does not undertake any obligation to update any forward-looking
statement, whether written or oral, to reflect events or circumstances after the
date on which such statement is made. If the Company does update or correct one
or more forward-looking statements, investors and others should not conclude
that the Company will make additional updates or corrections with respect
thereto or with respect to other forward-looking statements.
39
Item 3. Quantitative and Qualitative Disclosure about Market Risk
Interest Rate Risk
Market risk is the risk of loss in a financial instrument arising from adverse
changes in market rates, price, or credit risk. The Company has a de minimus
amount of credit risk in its portfolio because of its long-standing policy of
purchasing low credit risk investments. Consequently, the primary market risk
exposure of the organization is interest rate risk. The composition of the
portfolio continues to heavily favor U.S. agency debentures, U.S agency
mortgage-backed pass throughs, U.S agency CMO's, and AAA rated insured municipal
bonds. As of September 30, 2002, these four security types (excluding Federal
Home Loan Bank stock and Federal Reserve Bank stock) accounted for over 95% of
total portfolio investments.
The ongoing monitoring and management of this risk, over both a short-term
tactical and longer-term strategic time horizon, is an important component of
the Company's asset/liability management process, which is governed by policies
established by its Board of Directors and reviewed and approved annually. The
Board of Directors delegates responsibility for carrying out the asset/liability
management policies to the Asset/Liability Management Committee (ALCO). In this
capacity, ALCO develops guidelines and strategies impacting the Company's
asset/liability management activities based upon estimated market risk
sensitivity, policy limits, and overall market interest rate-related level and
trends.
As the Company does not believe it is possible to reliably predict future
interest rate movements, it has maintained an appropriate process and set of
measurement tools which enable it to identify and quantify sources of interest
rate risk in varying environments. The primary tool used by the Company in
managing interest rate risk is income simulation. The analysis begins by
measuring the impact of differences in maturity and repricing all balance sheet
positions. Such work is further augmented by adjusting for prepayment and
embedded option risk found naturally in certain asset and liability classes.
Finally, balance sheet growth and funding expectations are added to the analysis
in order to reflect the strategic initiatives set forth by the Company.
Changes in net interest income are reviewed after subjecting the balance sheet
to an array of Treasury yield curve possibilities.
The following reflects the Company's one-year net interest income sensitivity
based on approximate asset and liability levels on September 30, 2002, assuming
no growth in the balance sheet, and assuming a 200 basis point instantaneous
upward rate shock in the prime rate, federal funds rate and the entire Treasury
yield curve and a similar 100 basis point instantaneous downward rate shock.
Regulatory Model
Rate Change Net Interest Income Net Interest Income
In Basis Points Dollar Change During First 12 Months Percent Change from Flat Rates
------------------------------------------------------------------------------------------
+200 bp $979,000 0.8%
-100 bp ($1.8 million) (1.4%)
Given the steepness in slope of the Treasury yield curve as of September 30,
2002, a second group of simulations was performed based on what the Company
believes to be conservative levels of balance sheet growth. These levels include
no growth in the Company's securities portfolio and low single digit loan
growth. Under this set of assumptions, were the slope of the yield curve to
change, holding short rates constant while flattening long-term rates over the
next 12 months, the net interest margin is projected to narrow modestly
(simulation B). If short term rates were to increase 200 basis points over the
next 12 months (holding long-term rates constant), margins are also projected to
narrow (simulation A).
40
Management Model
Rate Change Net Interest Income Net Interest Income
In Basis Points Dollar Change During First 12 Months Percent Change from Flat Rates
----------------------------------------------------------------------------------------------------------
A) Increasing Short Term Rates ($3.1 million) (2.4%)
B) Reducing Longer Term Rates ($2.2 million) (1.7%)
The preceding interest rate risk analysis does not represent a Company forecast
and should not be relied upon as being indicative of expected operating results.
These hypothetical estimates are based upon numerous assumptions including: the
nature and timing of interest rate levels (including yield curve shape),
prepayments on loans and securities, deposit decay rates, pricing decisions on
loans and deposits, reinvestment/replacement of asset and liability cash flows,
and others. While the assumptions are developed based upon current economic and
local market conditions, the Company cannot make any assurances as to the
predictive nature of these assumptions, including how customer preferences or
competitor influences might change. Furthermore, the sensitivity analysis does
not reflect actions that ALCO might take in responding to or anticipating
changes in interest rates.
Item 4. Controls and Procedures
Under the supervision and with the participation of our management, including
the President and Chief Executive Officer and Chief Financial Officer, the
Company has evaluated the effectiveness of the design and operation of our
disclosure controls and procedures within 90 days of the filing date of this
quarterly report, and, based on their evaluation, our President and Chief
Executive Officer and Chief Financial Officer have concluded that these controls
and procedures are effective. There were no significant changes in our internal
controls or in other factors that could significantly affect these controls
subsequent to the date of their evaluation.
Disclosure controls and procedures are our controls and other procedures that
are designed to ensure that information required to be disclosed in the reports
that the Company files or submits under the Exchange Act is recorded, processed,
summarized and reported, within the time periods specified in the Securities and
Exchange Commission's rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed by the Company is accumulated and
communicated to our management, including our President and Chief Executive
Officer and Chief Financial Officer, as appropriate to allow timely decisions
regarding required disclosure.
41
Part II. Other Information
Item 1. Legal Proceedings.
Not Applicable
Item 2. Changes in Securities.
Not Applicable
Item 3. Defaults Upon Senior Securities.
Not Applicable.
Item 4. Submission of Matters to a Vote of Securities Holders.
Not Applicable.
Item 5. Other Information.
Not Applicable.
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits required by Item 601 of Regulation S-K:
(21) Subsidiaries of the registrant
- Community Bank, N.A., State of New York
- Community Financial Services, Inc., State of New York
- Community Capital Trust I, State of Delaware
- Community Capital Trust II, State of Delaware
- Community Statutory Trust III, State of Connecticut
- Benefit Plans Administrative Services, Inc., State of New York
- CBNA Treasury Management Corporation, State of New York
- Community Investment Services, Inc., State of New York
- CBNA Preferred Funding Corporation, State of Delaware
- Elias Asset Management, Inc., State of Delaware
- CFSI Close-Out Corp., State of New York
- First Liberty Service Corporation, State of Delaware
b) Exhibits required by the Sarbanes-Oxley Act of 2002
(99.1) Certification of Sanford A. Belden, President and Chief
Executive Officer of the Registrant, pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of the Sarbanes-Oxley Act of 2002.
(99.2) Certification of David G. Wallace, Treasurer and Chief
Financial Officer of the Registrant, pursuant to 18 U.S.C. Section
1350, as adopted pursuant to the Sarbanes-Oxley Act of 2002.
c) Reports on Form 8-K:
Not Applicable.
42
SIGNATURES
Pursuant to the requirements of The Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Community Bank System, Inc.
Date: November 14, 2002
/s/ Sanford A. Belden
-----------------------------------
Sanford A. Belden, President and
Chief Executive Officer
Date: November 14, 2002 /s/ David G. Wallace
-----------------------------------
David G. Wallace, Treasurer and
Chief Financial Officer
43
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
CERTIFICATIONS
I, Sanford A. Belden, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Community Bank System,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
/s/ Sanford A. Belden
-------------------------------------
Sanford A. Belden,
President and Chief Executive Officer
November 14, 2002
44
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
CERTIFICATIONS
I, David G. Wallace, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Community Bank System,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
/s/ David G. Wallace
--------------------------------------
David G. Wallace,
Treasurer and Chief Financial Officer
November 14, 2002
45